Gordon Growth Model (GGM)

• The GGM is a variation on the standard DDM that allows the analyst to assume that dividends will grow in perpetuity at a constant rate.

V0 = Div1 /(rce - gdiv)

• Div1 = D0 * (1 + gdiv) = future period dividend payment

• rce = by now you should know this!

  In an exam problem CFA might make you derive the required return on common equity via CAPM.

• gdiv = growth rate of the dividend

• Note that in order for GGM to "work", the required return on common equity must be greater than the expected growth rate of the dividend.

• GGM can also be used to value preferred stocks, whose dividend payments are fixed.

Preferred Stock V0 = Pref Div /r preferred stock

• GGM can be appropriate when:

• The analyst is looking at broad equity indexes.

• The analyst is valuing steadily growing companies that pay dividends.

• GGM has drawbacks of:

• Being incredibly sensitive to small changes in the model inputs.

• An inability to value companies that do not pay dividends.

• An inability to value companies whose growth is not stable.